Monday Note

(Last of a series — for a while.)

Launching an antitrust probe against books publishers, as the US Department of Justice might do, can’t come at a weirdest time. In the two previous Monday Notes, we explained how Amazon is maneuvering itself into a position to dominate the entire book industry. The Seattle giant keeps moving up the food chain, from controlling ebooks distribution (in addition to selling print books), to competing against publishers and even agents by luring best selling-authors. No one would bet a dime on the printed book as it reaches its peak while ebooks sales keep exceeding expectations.

Then, why does the DOJ waves the threat of an antitrust action?

Five publishers –and one distributor, Apple– are in the the US administration’s crosshairs:  Hachette Book Group (a division of Lagardère Group), Simon & Schuster (CBS Corp),  MacMillan (Holtzbrinck GmbH), Penguin (Pearson PLC), and HarpersCollins (News Corp). All are said to be suspected of ebooks prices collusion. (The Wall Street Journal broke the story on March 9th).

First, some background. There are two competing distribution models for printed books, electronic books and electronic newspapers as well: the wholesale model and the agency model. Using the wholesale model, the publisher sells its goods to the distributor for a fixed price — say half of the suggested street price — and the distributor is free to decide the actual price to the public. In the agency model, the publishers set the retail price, the distributor gets a fee (30% or so) and that’s it.

Amazon is fond of the wholesale model. But, in order to effectively enter a new market, the company had to make concessions. For example, in the newspaper business Amazon reluctantly yielded to the demands of European publishers who preferred the agency model. French publishers went for this arrangement last year (but they priced their publications too high, forgetting that a real e-paper format has nothing to do with PDF facsimile or a digital edition loaded with features). In the UK, British newspapers went for the wholesale model, much cheaper for the customer: they are doing well with lower margins and much higher volumes. (Price elasticity is a proven concept for digital publishing).

In the US market, Amazon offers nothing but the wholesale model. You end up with absurdly low prices:

…While the French weekly Paris Match won’t accept any discount:

… At least on Amazon. On the Relay.com digital kiosk, the magazine is sold for €1.59 ($2.08) per copy.

When it comes to selling newspapers or books, the wholesale model doesn’t seem to favor the publisher, this for three main reasons:

– The wholesale model’s primary goal is to serve the retailer’s overall strategy. Let’s assume Amazon wants to strengthen its general e-distribution market share and to increase sales of its Kindle product line. Then, the price of the primary product becomes secondary: it is in the company’s best interest to price-dump ebooks top-sellers in order to stimulate the sale of other products, or to up-sell high-margin items through its incredible recommendation engine –something Amazon is extremely good at. The entire retail sector strategy is based on a similar combination of moves.

– This makes the wholesale model is a deflationary one. Once it has acquired the rights to distribute a book (print or digital), the retailer is free to lower its margin as it sees fit, even going into negative territory (provided there is no law, such as in France, that prevents dumping practices). As a side effect, consumers gets used to low prices, ignoring the fact such prices may or may not reflect the item’s true economic value: a bestseller acquired for $14 by Amazon will be sold for a discounted $9.99. Once the the consumer bites, the retailer catches up by selling other higher margin products and/or hooking the customer into its system.

That’s why, when Apple launched its iBooks Store, publishers stuck inside Amazon’s wholesale system were willing to take their chances. They asked Steve Jobs for the agency model: price set by them and Apple taking its 30% cut. Jobs obliged, he wanted to boost iPad sales and, to do that, needed to attack Amazon’s domination of the ebook market. (Kindle formats currently accounts today for 60% of total sales). Jobs’ move put publishers in a position to go back to Amazon and ask for the same conditions.

Coming back to the DOJ’s looming antitrust action, did the book publishing industry collude in trying to pressure Amazon to change its practices? I don’t know if they acted in concert (people talk, you know) but they moved in accordance to their best interest by taking advantage of the newcomer, Apple. Now it seems the dispute over pricing has resumed: last month, Amazon pulled out 4,000 ebooks from one of the biggest books distributors in the US, the Independent Publishers Group (story in the New York Times here).

Pricing an item should be left to the one who produces it. The case of the book publishing industry is not as simple as, say, an appliance maker looking for the most potent retail channel for its hair-dryers or its toasters. The book sector is entering a painful transition: First, it needs to respond to consumers who want a large catalog of inexpensive ebooks; two, there is a plateauing but still strong print market ($73 billion worldwide). Managing a smooth decline for this segment is key to the industry’s health, especially as the ebook market yields thinner margins. Legacy publishers are culturally ill-equipped for such a difficult transition: they now find themselves competing with the agile, cash-rich, data and technology-driven players of the digital world.

—frederic.filloux@mondaynote.com

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